Basic guide to exchange rates: get answers to 12 frequently asked questions.
Exchange Rates FAQ
1. What are exchange rates?
Exchange rates are the values of one currency compared to another. The money of each country has a unique value compared to the money of another. In other words, the exchange rate determines how much of one currency you get for another.
In November 2021, for example, five US dollars bought you 650 Icelandic krona, roughly 32 Chinese yuan, 15.5 Israeli new sheqalim, and just 4.3 euros. Very visibly, there is a big difference.
International exchange rates fluctuate daily and can vary greatly from country to country. The value of a currency depends a lot on the economic situation of the country, as well as other factors, such as monetary policy, world trade and political stability.
2. How are exchange rates determined?
Exchange rates vary based on supply and demand and other economic factors. No bank, government or financial service determines an exchange rate. They instead, fluctuate based on global market conditions.
As supply and demand increases, the value of a currency increases. A decrease in supply and demand would lead to decrease of the value of said nation’s currency. Exchange rates are directly related to the economic prosperity of a country
Many other factors can affect exchange rates, including government debt, interest rates, inflation, and even a country’s deficit.
In other words, the economic health of a country has a direct impact on the value of its currency in the global market.
3. Why do exchange rates fluctuate?
Currency exchange rates are constantly fluctuating because global markets change every day. Interest rates, supply and demand, and other economic factors change from minute to minute!
Exchange rates fluctuate at the same speed. Currency exchange rates are a current reflection of a country’s economic health, and the value of its currency changes as its economy does.
4. Is a higher or lower exchange rate better?
If you are going to buy or send money, a higher exchange rate is more favourable for you. That’s because you get more for every dollar you send since the rate is high.
On the other hand, if you are going to sell money, a lower exchange rate is convenient for you, since it will allow you to obtain more foreign currency in exchange for what you will sell.
5. Why is the exchange rate important?
Currency exchange rates are important because they also determine the price of goods in the US and abroad. For example, the prices at which American products are sold abroad depend on the exchange rate. The cost of imported goods compared to local goods also influences.
The exchange rate impacts the value of imports directly, which can also affect both supply and demand in the global market. That means it will affect the US dollar exchange rate .
6. How does inflation affect exchange rates?
Inflation has a direct impact on interest rates, which play an important role in determining exchange rates. Inflation can cause interest rates to go up or down.
In turn, this can affect the exchange rate of different currencies in the global market.
The value of money is no longer backed by gold, but by governments ( fiat or fiat money ), so inflation can fluctuate and rise more easily than it was in the 1970s and earlier.
7. What makes the dollar (USD) strong or weak?
The US dollar, or USD, is perhaps the most powerful currency in the world. A strong US dollar allows you to buy more of any other currency. A weak dollar means that with 1 USD you buy less of any other currency.
Note: Other hard currencies include the Euro (EUR), the British Pound (GBP), the Japanese Yen (JPY), the Swiss Franc (CHF), and the Saudi Riyal (SAR).
The strength of the dollar depends on the economic health of the United States of America. Low debts and increased supply and demand can help strengthen the dollar.
On the other hand, high levels of unemployment, rising debt, and declining supply and demand can weaken the dollar.
Did you know that the United States is not the only country that uses dollars? Other popular dollars include: the Canadian dollar (CAD), the Australian dollar (AUD), the New Zealand dollar, the Singapore dollar, and the Hong Kong dollar.
8. What else can increase an exchange rate?
When a country’s currency is in high demand, its value will increase. The exchange rate can also rise as a country’s economic health improves.
Increases in interest rates and trade can also produce a favourable exchange rate. For example, many countries buy goods in US dollars. If more countries choose to use US dollars, more countries will buy this currency, which can further increase its value.
9. What else can decrease an exchange rate?
An exchange rate can decrease as the value of the dollar decreases. Economic difficulties, lower demand for the country’s currency on the world market, lower supply and demand for exports, and lower interest rates can weaken the value of the dollar.
When the dollar weakens, the exchange rate can decrease. These types of fluctuations can vary from day to day.
10. What is a flexible or floating exchange rate?
A floating exchange rate is when the exchange rate varies based on supply and demand in the foreign exchange market (also known as Forex) relative to other countries. This means that exchange rates will vary widely and that the value of exchange rates can change drastically depending on various economic factors.
Floating exchange rates are very common in countries that use fiat or fiat currencies.
11. What is a fixed exchange rate?
A fixed exchange rate system is when a country’s central bank bases the value of its currency on a given factor or measure of value. Gold used to be used for this purpose. Today, a fixed exchange rate generally means that the value of that currency is adjusted based on the value of another reference currency. The West African CFA franc is an example.
Very few countries still use this system. Most follow the fiat system, in which the government backs the currency.
12. How to find an exchange rate
You can check the exchange rates of different currencies online or at your favourite bank. Many financial services post current exchange rates on their websites.
When you are ready, you can buy or sell different currencies at any bank or exchange house. You can also send money abroad with a money transfer app or service. The exchange rate usually includes the cost of shipping.
When sending money to another country , follow the exchange rates for your currency pair and familiarize yourself with them. This way, you will know when the exchange rates suit you.
Another way to follow the exchange rate is to follow the world news. Economic developments and political changes can give you an idea of how the exchange rate will vary in the coming weeks or days.